What is a commodity and how does that relate to cannabis?

Guest Post

This month’s Guest Post is written by Keith Holecek, Managing Director of Data Operations & Client Services at Cannabis Benchmarks®.

Keith has over 17 years of experience delivering software & services to commodity market decision-makers and is excited to introduce these topics to cannabis industry participants.

Key Takeaways:

Cannabis wholesale prices are dropping in the most mature and competitive US markets

Understanding when and how wholesale prices change can help your business

You can apply lessons from other markets to better understand the cannabis industry

Wholesale price of cannabis continues to fall

2017 demonstrated a continuation of declining prices for wholesale cannabis flower. The graph below shows the U.S. Wholesale Cannabis Spot Index from April 2015 through December 2017 where we see frequent price fluctuations, the impact of outdoor harvests at the end of the year, and, most importantly, the overall downward trend that’s squeezing profits for nearly every cultivator.

So how can cultivators prepare themselves for shrinking margins and increased competition? The first step to maximizing revenue is to understand the Spot Index and how it’s important for your business.

We can learn about wholesale cannabis pricing by looking at other industries

Wholesale cannabis sellers & buyers can experience rapid changes in price that are common in corn, soybean, wheat and other major agricultural products. Much like cannabis, these products often experience price fluctuations such as peaking prices buoyed by overall demand or falling prices following robust harvests. Oftentimes, products from industries such as agriculture are referred to as “commodities” because they are interchangeable.

If we think of an agriculture product as a commodity, then a commodity market is a physical or virtual marketplace for buying, selling, and trading those products. There are different types of commodity markets. Cannabis currently exists in a Cash, or Spot Market. In a Spot Market, participants agree to a price per unit (e.g. $/lb) and the product is physically delivered often on the same day. More mature commodities also have Forwards and Futures Markets. While Forward arrangements can be highly structured contracts, they can also have attributes unique from one Forward arrangement to the next. In a Futures Markets, contracts are established where the product is scheduled for future delivery at a fixed price (or an agreed upon method for determining the price) that is set today. A Futures Contract is a guarantee for a transaction at a later date, based on attributes defined in a standardized contract, and executed on a regulated Futures Exchange.

Traditionally, businesses like to know what others are paying for a similar product to know what they should charge. In commodity markets, this is referred to as the “benchmark price” and is used as a reference in negotiations for both Spot, Forwards and Futures contracts. For the cannabis industry, a benchmark price is the average price per pound of raw flower calculated from a sample of completed wholesale transactions, during the same time period and within the same market. Individual prices will vary from the benchmark price based on quality, volume, and location. For example, a cultivator may charge more than the benchmark if their product tests high for desired terpene and cannabinoid levels. Alternatively, a cultivator may negotiate a lower price per pound if they are selling a large amount of product, if the product has been on the shelf for a while, or they are trying to clear inventory for the next upcoming harvest.

Cannabis Benchmarks®, an independent Price Reporting Agency, collects wholesale price data from market participants to build a benchmark for the industry. This benchmark is then used by buyers, sellers, and investors as a reference for strategy and negotiations.

Cultivating cannabis is complicated and challenging, and profit margins are impacted by electricity and water rates, sourcing of supplies, state regulations and, of course, the selling price per pound of product. Because there are so many factors that impact cultivation costs, growers need to accurately understand and negotiate their market price to minimize the risk of losing money.

Analyzing trends displayed in historical benchmark prices for cannabis enables cultivators to identify when their product might sell for the best price. If an outdoor cultivator can produce a healthy early season crop, they might have an opportunity to sell at a higher price ahead of the fall harvest.

Greenhouse cultivators continue to advance the technologies and techniques used in their operations. Many producers have been able to increase the number of harvests each year, allowing them to sell more product, and have greater flexibility in choosing the time at which their product is brought to market, while simultaneously reducing the risk that a single poor harvest can have on an organization producing only one or two harvests per year.

For example*, let’s consider a greenhouse cultivator in Oregon that has an overall cultivation cost of $700 to produce a single pound of sellable flower. If this cultivator sold 4 lots of 10 lbs in April 2017 they would have, on average, sold their product for $1,850 per pound, a gross profit of $1,150 per pound (=$1,850 selling price per pound – $700 cultivation cost per pound) or a total gross profit of $46,000 (=$1,150 profit * 4 lots * 10 lbs / lot). The same cultivator that sold the same 4 lots of 10 lbs in November 2017 would have, on average, sold their product for $1,450 per pound for a gross profit of $750 per pound or a total gross profit of $30,000. That’s a difference of $16,000 in the gross profit margin!!

In short, the same grower can earn almost 2x more selling the same amount of the same product at two different times of the year.

April 2017

November 2017

Number of lots

4

4

Pounds per lot

10

10

Cultivations cost per pound

$700

$700

Selling price per pound

$1850

$1450

Gross profits per pound

$1150

$750

Total gross profit of transaction

$46,000

$30,000

*Cultivation cost for 1 pound of greenhouse grown flower is an assumption used for this example. Oregon Greenhouse Spot Prices are based on Cannabis Benchmarks® reporting for this time period.

Overall, when and how much one sells can dramatically impact profit levels. For this reason, it’s important to understand and plan for the market rate in your region.

In our next article, we will provide you with a step-by-step process for internal & external benchmarks and how they relate to wholesale price trends in your business.